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Apple to Pandora: You're Out

Things are looking rough for the Internet radio pioneer.

The iPhone 5 launch on Wednesday, Sept. 12, is sure to be the most important event for tech investors this year. The Motley Fool will be hosting a live chat where our top tech analysts will answer your questions and break down what the announcement means for Apple and tech investors everywhere. Be sure to swing by Fool.com at 12:45 p.m. ET this Wednesday for all your coverage of Apple's next big announcement.

It's not very often that a company announces 50% year-over-year user growth of its service and shares go down 5%. It's also not very often that another company can make a quick announcement that puts your entire business on death row. I suppose the fact that both of those things can happen on the same day to a company is the perfect argument for why investing in high-growth technology is dangerous and unpredictable. Though my mild frustration with tech stocks probably doesn't compare with the turmoil going on at Pandora's (Nasdaq: P) headquarters. Watch out, investors: Things aren't looking too good.

Last week's zingerIn what was probably the worst Friday afternoon ever for a cool and hip tech company, Pandora found out from The Wall Street Journal that Apple(Nasdaq: AAPL) intends to jump into the Internet streaming-radio biz. How does a founder or CEO respond when the world's most profitable and cash-laden company wants to do what his company does? It was probably a "what if" question he never wanted to answer.

To add insult to injury, it's unlikely that Apple even really cares about the profitability, or lack thereof, in streaming radio. Pandora, even with incredible growth over the past year, is clawing for profitability. Royalty fees have kept the Internet radio pioneer away from true greatness ever since its inception, as it seems that regardless of how many users adopt the service, it can't make up for the amount Pandora has to pay to the artists and labels.

As for Apple, it isn't truly looking to steal the market away from Pandora. Pandora's $1.68 billion market cap doesn't put a dent in one year's profits for the Big Fruit. Apple is simply continuing its quest to dominate all things media-related on the Web. It makes sense for the company to offer a radio service, complimented by iTunes, complimented by iPhones, complimented by MacBooks, complimented by Apple TV, and on and on. Streaming radio is just another in-house application for Apple, not a profit center.

I'm sorry, Pandora, but you received about the worst news you could ever, possibly, conceivably, get. Ever.

On the bright side, but not reallyIn an effort to soften the blow and "be more transparent," Pandora this week announced its August statistics. The numbers sure are pretty:

56.2 million unique listeners in August, up 48% from the year before.

1.16 billion hours of music listened to, up 70% from the year before.

The thing is, these numbers come on the heels of Pandora's second-quarter earnings report, which showed bigger losses even with the drastic increase in users. It is, as mentioned, caused by an inability to reconcile royalty fees with the free, front-end service most of its customers use.

So investors are faced with a lovely conundrum: a company that can double its user base year over year and has a several-year head start on any new entrants in an expensive and difficult business -- but also can't seem to turn any of its millions of users into profits and has a 625-billion-pound gorilla lingering around its business.

Fool readers are probably accustomed to the term "margin of safety." If you aren't, let's consider this a lesson in what is the exact opposite of a margin of safety, qualitatively speaking.

Anything else?Pandora has been able to isolate its business from competitors such as Sirius XM(Nasdaq: SIRI). Though Sirius has offered in-home products and mobile apps in addition to its core, automobile-based service, it hasn't been viewed as a direct threat to Pandora, largely because Pandora is a highly personalized service -- predicting what we want to listen to given what we said we want to listen to. Pandora is also, as mentioned, free on its front-end service, where the majority of its users reside.

Sirius, in my opinion, doesn't pose much of a threat to Pandora's business. But that doesn't matter, because Pandora has about as many threats to its business as the Rules of the Universe allow.

Though these are the main news points regarding Pandora, there is much more to learn about both Apple and Sirius. Read the premium report for each to learn about the opportunities and obstacles facing both companies.

Author

Michael is a value-oriented investment analyst with a specific interest in retail and media businesses. Before coming to the Fool, Michael worked with private investment funds focusing on deep value and special situations. Currently living in the media capital of the world--Los Angeles, California.